CA Final G2 SFM Paper 2 Solution

8/18/2019 CA Final G2 SFM Paper 2 Solution

1/13

CA-FINAL # 1

Disclaimer Clause : These solutions are prepared by expert faculty team of RESONANCE. Views

and answers provided may differ from that would be given by ICAI due to difference in assumptions

taken in support of the answers. In such case answers as provided by ICAI will be deemed as final.

COMMERCE & LAW PROGRAM DIVISION (CLPD)

CA-FINAL (G-1)NOV. - 2014 (ATTEMPT)

Total number of questions : 7 | Time allowed : 3 hours | Maximum Marks : 100 | Date : 09-11-2014

PAPER- 2

SUBJECT : STRATEGIC FINANCIAL MANAGEMENT

NOTE : 1. Question No. 1 is compulsory. Answer any five questions from the remaining six questions.

2. Working notes should form part of the answers.


2/13

CA-FINAL # 2

1. (a) Edclweiss Bank Ltd. sold Hong Kong dollar 2 crores value spot to its customer at ` 8.025 and

covered itself in the London market on the same day, when the exchange rates were

US $ 1 = HK $ 7.5880 – 7.5920

Local interbank market rates for US $ were

Spot US $ 1 = ` 6O.70 – 61.00

Calculate the cover rate and ascertain the profit or loss on the transaction, Ignore brokerage.

[ 5 Marks ]

Sol. (a) To cover in London Market, bank will buy HKD 2 crore, for this ask rate will be require –

HKD

` =

$US

` ×

HKD

$US = 61.00 ×

5880.7

1 = 8.0390

Hence rate will be ` 8.0390/HK$

Calculation of profit and loss

Sale 2 crore × 8.025 = 16.05 crore

Buy 2 crore × 8.0390 = 16.078 crore

Net loss 0.028 crore

Hence net loss will be ` 2,80,000

1. (b) Wonderland Limited has cash of ` 20 lakhs. which it wants to invest in short term marketable

securities. Expenses relating to investment will be ` 50,000.

The securities invested will have an annual yield of 9%

The company seeks your advice

(i) as to the period of investment so as to earn a pre-tax income of 5%.

(ii) the minimum period for the company to break even its investment expenditure

over time value of money. [ 5 Marks ]

Sol.(b) (i) Investment in security = ` 20,00,000

Rate of return = 9 % p.a.

Expenses = 50,000

Hence to get a return of 5 % company should invest for a period

Investment × Requierd return = I × Rate ×12

n – Expenses

20,000,00 × 5 % = 20,00,000 × 9 % ×12

n – 50,000

1,00,000 + 50,000 =12

000,80,1 × n

n =15000

150000 = 10 months

(ii) Minimum break even period will beReturn = cost

2000000 × 9 % ×12

n= 50,000

! 1,80,000 × 12

n

= 50,000n = 3.33 months

Note: It is assumed that investment expenses is in additional to the amount of investment, Hence calulationhave been made considering ` 20 lakhs as net investment.

1. (c) Elrond Limited plans to acquire Doom Limited. The relevant financial details of the two firms prior tothe merger announcement are :

Elrond Doom

Limited Limited

Market price per share ` 50 ` 25

Number of outstanding shares 20 lakhs 10 Iakhs

The merger is expected to generate gains, which have a present value of ` 200 lakhs. The exchangeratio agreed to is 0.5.

What is the true cost of the merger from the point of view of Elrond Limited ? [ 5 Marks ]


3/13

CA-FINAL # 3

Sol. (c) True Cost of Merger will be net Consideration paid

= Number of share × Post merger MPS

= 10 lakhs × 0.5 × 58

= 290 lakhs

Calcuation of Post merger MPS

Pre merger value of Elrond Limited = 20 lakhs × 50 = 1000 lakhs

Pre merger value of Doom Limited = 10 lakhs × 25 = 250 lakhs

Gains from merger = 200 lakhs

Total = 1,450 lakhs

"Post merger number of shares = 20 lakhs + 5 lakhs = 25 lakhs

Post merger MPS = 58

1. (d) Goldilocks Ltd. was started a year back with equity capital of ` 40 lakhs, The other details are asunder :

Earnings of the company ` 4,00,000

Price Earnings ratio 12.5

Dividend paid ` 3,20,000

Number of Shares 40,000

Find the current market price share. Use Walters Model.

Find whether the company's D/P ratio is optimal, use Walter's formula. [ 5 Marks ]

Sol. (d) The EPS of the firm is ` 10 (i.e., ` 4,00,000/40,000). The P/E Ratio is given at 12.5 and the cost of

capital, ke, may be taken at the inverse of P/E ratio. Therefore, ke is 8 (i.e., 1/12.5). The firm is

distributing total dividends of ` 3,20,000 among 40,000 shares, giving a dividend per share of ` 8.00.

the value of the share as per Walter’s model may be found as follows:

P =

e

e

k

)D –E(k

rD $$

%

&''(

) *

=

08.0

)8 –10(08.0

10.08 $

%

&'(

) *= 131.25

The firm has a dividend payout of 80% (i.e., ` 3,20,000) out of total earnings of ` 4,00,000. since,

the rate of return of the firm, r, is 10% and it is more than the ke of 8%, therefore, by distributing

80% of earnings, the firm is not following an optimal dividend policy. The optimal dividend policy for

the firm would be to pay zero dividend and in such a situation, the market price would be

P =

e

e

k

)D –E(k

rD $$

%

&''(

) *

=

08.0

)0 –10(08.0

10.00 $

%

&'(

) *= 156.25

So, theoretically the market price of the share can be increased by adopting a zero payout.

2. (a) The valuation of Hansel Limited has been done by an investment analyst. Based on an expectedfree cash flow of ` 54 lakhs for the following year and an expected growth rate of 9 percent. theanalyst has estimated value of Hansel Limited to be ` 1800 lakh. However, he committed a mistakeof using the book values of debt and equity.

The book value weights employed by the analyst are not known, but you know that Hansel limitedequity of 20 percent and post tax cost of debt of 10 percent. The market of equity thrice its bookvalue, whereas the market value of its debt is nine-tenths of its book value. What is the correct valueof Hansel Ltd ? [ 6 Marks ]

Sol. (a) Calculation of wrong KO taken by analyst –

Value = g –K

CF

O

1800 = 09.0 –k54

0

KO = 0.12 or 12 %


4/13

CA-FINAL # 4

Let us assume

book value of debt = x

then book value weight of equity = 1 – x

Hence KO = wewd

)weke()wdkd(

*+*+

! 12 = )x –1(x

)x –1(20x10

*

*+

! 12 = 10 x + 20 – 20 x

! x =10

8 = 0.80

wd = 0.80

we = 1 – 0.80 = 0.20

Correct value of weights will be

wd = 0.80 ×10

9 = 0.72

we = 0.20 × 3 = 0.60

Hence revised k0 will be

wewd

wekewdkd

*+*+

60.072.0

60.02072.010

*+*+

=32.1

122.7 * = 14.5454

Hence correct value will be

value = g –k

CF

0 =

09.0 –145454.0

54 = 973.78

2. (b) Gretel Limited setting up a project for manufacture of boats at a cost of ` 300 lakhs. It shore(Area A) decide whether to locate the plant in next to the sea in a inland area wIth no accessto any waterway (Area B). If the project is located in Area B then Gretel Limited receives a cashof ` 20 Iakhs from the Central Government. Besides. the taxable profits to the extent 20%exempt for 10 years in Area B. The project envisages a borrowing ` 200 lakhs in either case.The rate of interest per annum is 12% in Area A and 10% in Area B.

The borrowing of principal has to be repaid in 4 equal installments beginning from the end of the4th year.

With the help of the following information. are required suggest the proper location for theproject to CEO of Gretel Limited. Assume straight line depreciation with residual value, incometax 50% and required of return 15%. [ 10 Marks ]

Earnings before Depreciation, Interest and Tax (EBDIT)

Year (

In lakhs)

AreaA AreaB

1 (6) (50)

2 34 (50)

3 54 10

4 74 20

5 108 45

6 142 100

7 156 155

8 230 190

9 330 230

10 430 330

The PVIF @ 15% for 10 year are as below :Year 1 2 3 4 5 6 7 8 9 10

PVIF 0.87 0.76 0.66 0.57 0.50 0.43 0.38 0.33 0.28 0.25


5/13

CA-FINAL # 5

Sol.(b) 1. Computation of Interest

Detail Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7

(For Area A) Opening Principal 200 200 200 200 150 100 50

Less: Repayment (0) (0) (0) (50) (50) (50) (50)

Closing Principal 200 200 200 150 100 50 0

Interest @ 12% (on Opening 24 24 24 24 18 12 6

(For Area B) Interest @ 10% 20 20 20 20 15 10 5

2. Computation of Future Cash Flow & NPV

Nature Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 6 Yr 7 Yr 8 Yr 9 Yr 10

(For Area A) EBDIT (6) 34 54 74 108 142 156 230 330 430

300

Less: Depreciation =10 (30) (30) (30) (30) (30) (30) (30) (30) (30) (30)

EBIT (36) 4 24 44 78 112 126 200 300 400

Less: Interest (WN1) (24) (24) (24) (24) (18) (12) (6) 0 0 0

EBT (60) (20) 0 20 60 100 120 200 300 400

Less: Tax @ 50% - - - - - 50 60 100 150 200

EAT (60) (20) 0 20 60 50 60 100 150 200Add: Depreciation 30 30 30 30 30 30 30 30 30 30

CFAT (30) 10 30 50 90 80 90 130 180 230

Less: Principal – – – (50) (50) (50) (50) – – –

Net cash flow (30) 10 30 0 40 30 40 130 180 230

DF @ 15% as given 0.87 0.76 0.66 0.57 0.5 0.43 0.38 0.33 0.28 0.25

DCF (26.1) 7.6 19.8 0 20 12.9 15.2 42.9 50.4 57.5

Total DCF 200.2

Less: Initial Investment (Net of Loan Amount) (300 – 200) 100

NPV 100.2

(For Area B) EBDIT (50) (50) 10 20 45 100 155 190 230 330

300

Less: Depreciation 10

(30) (30) (30) (30) (30) (30) (30) (30) (30) (30)

EBIT (80) (80) (20) (10) 15 70 125 160 200 300

Less: Interest (WN1) (20) (20) (20) (20) (15) (10) (5) 0 0 0

EBT (100) (100) (40) (30) 0 60 120 160 200 300

Less: Tax @ 50% - - - - - - - 28 80 120

EAT (70) (70) (28) (21) 0 42 84 132 120 180

Add: Depreciation 30 30 30 30 30 30 30 30 30 30

CFAT (40) (40) 2 9 30 72 114 162 150 210

Less: Principal –

–

–

(50) (50) (50) (50) –

–

–

Net cash flow (40) (40) 2 (41) (20) 22 64 162 150 210

DF @ 15% as given 0.87 0.76 0.66 0.57 0.5 0.43 0.38 0.33 0.28 0.25

DCF (34.8) (30.4) 1.32 (23.37) (10) 9.46 24.32 53.46 42.0 52.5

Total DCF 74.32

Less: Initial Investment (300 –200 –20) 80.0

NPV (5.68)

Since, NPV of Area A is greater than NPV of Area B the CEO shall locate the Project in Area A which

is more beneficial.

Note: (1) Losses of the project are carry forward to next profitable year and set off there and

accordingly calculated the tax amount.(2) Subsidy is assumed in promoters contribution nature.

(3) Equity point of you is taken hence loan cash flows are considered.


6/13

CA-FINAL # 6

3. (a) Gibralter Limited has imported 5000 bottles of shampoo at landed cost in Mumhai.of US $ 20

each The company has the choice for paying for the goods immediately or in 3 months time. It

has a c lean overdraft limit where 14% p.a.rate of interest is charged. [ 8 Marks ]

Calculate which the following method would he cheaper to Gibralter Limited.

(i) Pay in 3 months time with interest @ 10% and cover risk forward for 3 months.

(ii) Settle now at a current spot rate and pay interest of the overdraft for 3 months.

The rates are as follow :Mumbai `/$ spot : 60.25 – 60.55

3 months swap : 35/25

Sol. (a) (i) Pay in 3 months time

Landed cost 5,000 × 20 = 1,00,000

Add : Interest @ 10 % = 2,500

Total payment = 1,02,500

convesrion in ` @ 60.30 = ` 61,80,750

(ii) Pay immediately

landed cost 5,000 × 20 = 1,00,000

convesrion in ` @ 60.5 = 60,55,000Add :Interest @ 14 % = 2,11,925

= ` 62,66,925

Advice : It is better for Gibralter Limited to pay in 3 months time because it will be chepaer.

3. (b) The risk free rate of return Rf is 9 percent. The expected rate of return on the market portfolio R

m

is 13 percent. The expected rate of growth for the dividend of Platinum Ltd. is 7 percent. Thelast dividend paid on the equity stock of firm A was ` 2.00. The beta Platinum Ltd. equity stockis 1.2.

(i) What is the equilibrium price of the equity stock of Platinum Ltd. ?

(ii) How would the equilibrium price change when

!

The inflation premium increases by 2 percent ?! The expected growth rate increases by 3 percent ?

! The beta of Platinum Ltd. equity rises to 1.3 ? [8 Marks ]

Sol. (b) (i) Price = g –k

D

e

1

D1

= D0 ( 1 + g)

= 2 (1 + 0.07) = 2.14

ke

= RF + (Rm – R

F) ,

= 9 + (13 – 9) 1.20

= 13.8 or 0.138

g = 0.07

Price =07.0 –138.0

14.2 = ` 31.47

(ii) Revised ke will be

RF + (R

M – R

F) × B

! 9 + ((13 – 9) + 2) × 1.30

= 16.8

g = 0.10

D1

= 2(1 + 0.10) = 2.20

Hence

price = g –kD

e

1 =

10.0 –168.010.2

= ` 30.88

Note: Alternatively effect of each component on price can be shown seprately


7/13

CA-FINAL # 7

4. (a) Beanstalk Ltd. manages its accounts receivable internally by its sales and credit department.The cost of sales ledger administration stands at ` 10 crores annually. The company has acredit policy of 2/10. net 30. Past experience of the company has been that on an average 40percent of the customers avail of the discont by paying within 10 days while the balance of thereceivables are collected on average 90 days after the invoice date. Bad debts of the companyare currently 1.5 percent of total sales. The projected sales for the next year are ` 1000 corores.

Beanstalk Ltd.. finances its investment in debtors through a mix of bank credit and own longterm funds in the ratio of 70 : 30. The current cost of bank credit and long term funds are 13percent and 15 percent respectively.

With escalating cost associated with in house management of debtors coupled with theneed to unburden the management with the sales promotion, the Company is examining thepossibility of outsourcing its factoring service for managing its receivable and has twoproposals on hand with a guaranteed payment within 30 days.

The main elements of the Proposal 1 from Finebank Factors Ltd. are:

! Advance, 88 percent and 84 percent for the recourse and non recourse arrangements.

! Discount charge in advance. 21 percent for with recourse and 22 percent without

recourse.

! Commission. 4.5 percent without recourse and 2.5 percent with recourse.

The main elements of the Proposal II from Roughbank Factors Ltd. are :

! Advance, 84 percent with recourse and percent without recourse respectively.

! Discount charge upfront without recourse 21 percent and with recourse 20 percent.

! Commission upfront, without recourse 3.6 percent and with recourse 1.8 percent.

The opinion of the Chief Marketing Manager is that inthe context of the factoring arrangement.

his staff would be able exclusively focus on sales promotion which would result in additionalsales of 10% of projected sales. Kindly advice as a financial consultant on the alternativeproposals. What advice would you give ? Why [ 12 Marks ]

Sol.(a) 1. Proposal I - Factoring from Finebank Factors Ltd

Details With Recourse Without Recourse

1. Benefits

(1) Bad Debts 0 15

[1000 × 1.5%]

(2) Saving in interest 21.91 21.91

(3) Discount 8.00(1000 × 40 % × 2 %) 8.00(1000 × 40 % × 2 %)

Costs

Factoringcommission

25.00

(1000 × 2.5%)

45.00

(1000 × 4.5%)

Interest to factoron advance

15.40

(1000 × 88% × 21% × 30/360)

15.40

(1000×84%×22%×30/360)

Interest on ownfund

1.50

(1,000 × 12 % × 15% × 30/360)

2

(1000 × 16 % × 15% × 30/360)

Net Benefit/cost (11.99) (17.49)


8/13

CA-FINAL # 8

2. Proposal I I - Factoring from Roughbank Factors Ltd

Details With Recourse Without Recourse

1. Benefits

(1) Bad Debts 0 15

[1000 × 1.5%]

(2) Saving in 21.91 21.91(3) Discount 8.00

(1000 × 40 % × 2 %)

8.00

(1000 × 40 % × 2 %)

Costs

Factoringcommission

18.00

(1000 × 1.8%)

36.00

(1000 × 3.6%)

Interest to factor onadvance

14.385

(1000 × 84% - 18) × 21% × 30/360

12.73

(1000×80% - 36) ×20%×1/12

Interest on ownfund

2.225(1000 × 16% + 18) × 15% × 30/360

2.5

(1000 × 20% + 36) × 15% 30/360

Net Benefit/cost (4.70) (6.32)

Note 1: Saving in Interest

= Average Debtors due × WACC = 161.11 × 13.60% = ` 21.91 Crores

Note 2: Calculation of Average Debtors

Total Credit Sales = 1000 Crores TYPE I: 40% repaying within 10 Days i.e. ` 400 II: 60% repaying within 90 Days i.e. ` 600

Average O/s360

400× 10 days = ` 11.11 Crores

360

600× 90 days = ` 150.00 Crores

Total 11.11 + 150.00 = 161.11 Crores

Note 5: WACC for Debtors funding

Details Ratio % Product

Equity 0.30 15 4.50

Bank Credit 0.70 13 9.10

13.60

Note: Benefit due to increase in sales are same in all cases Hence ignored for decision making

purpose. If such benefit higher than 4.70 crore then we should accept factoring from rough

bank with recourse.

(b) Cinderella Mutual Fund has the following assets in Scheme Rudolf at the clsoe of business on

31st March, 2014.

Company No. of Shares Market Price Per Share

Nairobi Ltd. 25000 ` 20

Dakar Ltd. 35000 ` 300

Senegal Ltd. 29000 ` 380

Cairo Ltd. 40000 ` 500

The total number of units of Scheme Rudolf are 10 lacs. The Scheme Rudolf has accrued

expenses of ` 2,50,000 and other liabilities of ` 2,00,000. Calculate the NAV per unit of theScheme Rudolf.

[4 Marks]


9/13

CA-FINAL # 9

Sol. (b) Calculation of NAV Per unitParticulars Amount

Nairobi Ltd. 25000 × 20 5, 00,000

Dakar Ltd. 35000 × 300 10,50,000

Senegal Ltd. 29000 × 380 1,10,20,000

Cairo Ltd. 40000 × 500 2,00,00,000

4,20,20,000

Less : Liabilities

Accrued Expenses 2,50,000

Other Liabilities 2,20,000

Net Assets 415,50,000

No. of units 10,00,000

NAV 41.55

5. (a) Buenos Aires Limited has 10 lakh equity shares outstanding at the beginning of the year 2013.The current market price per share is ` 150. The company is contemplating a dividend of ` 9per share. The rate of capitalization. appropriate to its risk class, is 10%.

(i) Based on MM approach. calculate the market price of the share of the company when:

(1) Dividend is declared

(2) Dividend is not declared

(ii) How many new shares are to be issued by the company. under both the above options,if the Company is planning to invest ` 500 lakhs assuming a net income of ` 200lakhs by the end of the year ? [ 8 Marks ]

Sol. (a) (i)

(1) If dividend is declared

P1

= P0 (1 + ke) – D

1

= 150 (1.10) – 9

= 156(2) If dividend not declared

P1

= P0 (1 + ke) – D

1

= 150 (1.10) – 0

= 165

(ii)

Calculation of new share to be issued

(1) -n =1

1

P

)nD –E( –I

=156

)910 –200( –500 += 2.5 lakh or 2,50,000 shares

(2) -n =165

)010 –200( –500 +

= 1.818 lakh shares

or 1,81,818.18 shares

(b) Odessa Limited has proposed to expand its operations for which it requires funds of $ 15million, net of issue expenses which amount to 2% of the issue size. It proposed to raise thefunds though a GDR issue. h considers the following factors in pricing the issue :

(i) The expected domestic market price of the share is ` 300

(ii) 3 shares underly each GDR

(iii) Underlying shares are priced at 10% discount to the market price

(iv) Expected exchange rate is ` 60/$You are required to compute the number of GDR's to be issued and cost of GDR to OdessaLimited, if 20% dividend is expected to be paid with a growth rate of 20%. [ 8 Marks ]


10/13

CA-FINAL # 10

Sol. (b) 1. Basics

(a) Fund Requirement = 15 million USD

(b) Issue Cost = 2% of Issue size

(c) Issue Size = USDmillion31.15%)2 –100(

million15.

2. No. of GDR to Issue

(a) MPS of 1 Share = ` 300

(b) Issue Price of 1 Share = 300 – 10% discount = 270

(c) Issue Price of 1 GDR = 3 Shares

(d) Hence, Issue Price of 1 GDR (in INR) = 3 × 270 = 810

(e) Issue Price of 1 GDR (in USD) =60

810= 13.5 USD

No. of GDR = 15.31 million 13.5 = 1.134 million

3. Cost of GDR

(a) Ke = gP

D

o

1 * ×100

D1

=60

3%)20100( ++= 1

Po = 13.50 = 13.50

g = 20% = 0.20

Ke . $ %

&'(

) * 20.0

50.13

1×100 = 27.41%

Note: Face value of each share is assumed as 100

6. (a) Cauliflower Limited is contemplating acquisition of Cabbage Limited. Cauliflower Limited has 5lakh shares having market value of ` 40 per share while Cabbage Limited has 3 lakh shareshaving market value of ` 25 per share. The EPS for Cabbage Limited and Cauliflower Limitedare ` 3 per share and ` 5 per share respectively. The managements of both the companies arediscussing two alternatives for exchange of shares as follows:

(i) In proportion to relative earnings per share of the two companies.

(ii) 1 share of Cauliflower Limited for two shares of Cabbage Limited.

Required :

(i) Calculate the EPS after merger under both the alternatives.

(ii) Show the impact on EPS for the shareholders of the two companies under both thealternatives. [ 10 Marks ]

Sol. (a) Alternative 1 : Exchange in prportion of relative EPS

Exchange Ratio =5

3 = 0.6 : 1

No. of share to be issued = 3,00,000 × 0.6

= 180000

Total no. of share = 5,00,000 + 1,80,000

= 6,80,000

Calculation of post merger EPS

EAT of caulifower Ltd. (5 L × 5) 25,00,000

EAT of Cabbage Ltd. (3L × 3) 9,00,000

Post Merger earning 34,00,000

- New no. of shares 6,80,000

Post merger EPS 5

Impact on EPS.


11/13

CA-FINAL # 11

Caulifower Ltd. Cabbage Ltd.

Post Merger 5 3

(5 × 0.6)

( –) Pre Merger 5 3

Nil Nil

Alternative 2 : 1 share for every 2 share

Exchange Ratio =2

1 = 0.5 : 1

No. of share to be issued = 3,00,000 × 0.5

= 1,50,000

Total no. of share = 5,00,000 + 1,50,000

= 6,50,000

Calculation of post-merger EPS

= sharesmergerPost

earningmergerPost =

000,50,6

000,00,34 = 5.2307

Impact on EPS

Cauliflower Cabbage

Post merger 5.2307 2.6153

(5.2307 × 0.5)

( –) Pre merger 5.00 3.00

Impact on EPS 0.2307 (0.3847)

6. (b) An investor is holding 5,000 shares of X Ltd. Current year dividend rate is ` 3/share. Market ofthe share ` 40 each. The investor is concerned about several which are likely to change during

the next financial year as indicated below :

Current Next

Year Year

Dividend paid/anticipated per share ( ` ) 3 2.5

Risk free rate 12% 10%

Market Risk Premium 5% 4%

Beta Value 1.3 1.4

Expected growth 9% 7% [ 6 Marks ]

In view of the above. advise whether the investor should buy. hold or sell the shares.

Sol. (b) As per CAPM Model E(RP)Under changing factos

E(RP) = R

F + (R

m – R

F) × ,

= 10 + 4 × 1.4

= 15.6

According to gordon model value of share should be

P =g –e

1

k

D

=07.0 –156.0

5.2

= 29.069

Idealy value should be 29.069, where as actual market price is ` 40 Hence investor should sellthe share.


12/13

CA-FINAL # 12

7. Write short notes on any four of the following : [ 4 × 4 = 16 Marks ]

(a) What are the signals that indicate that is time for an investor to exit a mutual fund scheme ?

Sol. (a) Signals highlighting the exit of the investor from the mutual fund scheme

(1) When the mutual fund consistently under performs the broad based index, it is high

time that it should get out of the scheme.

(2) When the mutual fund consistently under performs its peer group instead of it being atthe top. In such a case, it would have to pay to get out of the scheme and then investin the winning schemes.

(3) When the mutual fund changes its objectives e.g. instead of providing a regular incometo the investor, the composition of the portfolio has changed to a growth fund modewhich is not in tune with the investor’s risk preferences.

(4) When the investor changes his objective of investing in a mutual fund which no longer isbeneficial to him.

(5) When the fund manager, handling the mutual fund schemes, has been replaced by a

new entrant whose image is not known.

7. (b) What is cross border leasing? State objectives.Sol. (b) Cross-border leasing is a leasing agreement where lessor and lessee are situated in different

countries. This raises significant additional issues relating to tax avoidance and tax shelters. Ithas been widely used in some European countries, to arbitrage the difference in the tax laws ofdifferent countries.Cross-border leasing have been in practice as a means of financing infrastructure developmentin emerging nations. Cross-border leasing may have significant applications in financinginfrastructure development in emerging nations - such as rail and air transport equipment,telephone and telecommunications, equipment, and assets incorporated into power generationand distribution systems and other projects that have predictable revenue streams. A majorobjective of cross-border leases is to reduce the overall cost of financing through utilization by thelessor of tax depreciation all owances to reduce its taxable income, The tax savings are passed

through to the lessee as a lower cost of finance. The basic prerequisites are relatively high tax ratesin the lessor’s country, liberal depreciation rules and either very flexible or very formalistic rulesgoverning tax ownership.

7. (c) Explain Take over by reverse bid.Sol. (c) Generally, a big company takes over a small company. When the smaller company gains control of

a larger one then it is called “Take-over by reverse bid”. In case of reverse take-over, a small companytakes over a big company. This concept has been successfully followed for revival of sick industries.The acquired company is said to be big if any one of the following conditions is satisfied:

(i) The assets of the transferor company are greater than the transferee company;

(ii) Equity capital to be issued by the transferee company pursuant to the acquisition

exceeds its original issued capital, and(iii) The change of control in the transferee company will be through the introduction of

minority holder or group of holders.

Reverse takeover takes place in the following cases:(1) When the acquired company (big company) is a financially weak company

(2) When the acquirer (the small company) already holds a significant proportion of sharesof the acquired company (small company)

(3) When the people holding top management positions in the acquirer company want tobe relived off of their responsibilities.

The concept of take-over by reverse bid, or of reverse merger, is thus not the usualcase of amalgamation of a sick unit which is non-viable with a healthy or prosperousunit but is a case whereby the entire undertaking of the healthy and prosperous company

is to be merged and vested in the sick company which is non-viable.


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CA-FINAL # 13

7. (d) What are the risks to which foreign exchange transactions are exposed ?

Sol. (d) A firm dealing with foreign exchange may be exposed to foreign currency exposures. Theexposure is the result of possession of assets and liabilities and transactions denominated inforeign currency. When exchange rate f luctuates, assets, liabilities, revenues, expenses thathave been expressed in foreign currency will result in either foreign exchange gain or loss.

A firm dealing with foreign exchange may be exposed to the following types of risks:

(i) Transaction Exposure: A firm may have some contractually fixed payments andreceipts in foreign currency, such as, import payables, export receivables, interestpayable on foreign currency loans etc. All such items are to be settled in a foreigncurrency. Unexpected fluctuation in exchange rate will have favourable or adverse impacton its cash flows. Such exposures are termed as transactions exposures.

(ii) Economic Exposure: Economic exposure measures the probability that fluctuationsin foreign exchange rate will affect the value of the firm. The intrinsic value of a firm iscalculated by discounting the expected future cash flows with appropriate discountingrate. The risk involved in economic exposure requires measurement of the effect offluctuations in exchange rate on different future cash flows.

7. (e) Explain the term “insider Trading” and why Insider Trading is punishable ?

Sol. (e) The word insider has wide connotation. An outsider may be held to be an insider by virtue ofhis engaging himself in this practice on the strength of inside information.

Insider trading practices are lawfully prohibited. The regulatory bodies in general are imposingdifferent fines and penalties for those who indulge in such practices. Based on therecommendation of Sachar Committee and Patel Committee, SEBI has framed variousregulations and implemented the same to prevent the insider trading practices. Recently SEBIhas made several changes to strengthen the existing insider Trading Regulation, 1992 and newRegulation as SEBI (Prohibition of Insider Trading) Regulations, 2002 has been introduced.

Insider trading which is an unethical practice resorted by those in power in corporates hasmanifested not only in India but elsewhere in the world causing huge losses to common investors

thus driving them away from capital market. Therefore, it is punishable.

CA Final G2 SFM Paper 2 Solution

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